Sunday, August 24, 2014

PROFESSOR YINGXU WANG AND THE INVISIBLE HAND

“Was the classical illustration of Adam Smith’s invisible hand shown upside down between the curves of demand and supply in economics textbooks?:

“The conventional model of textbooks (Figure a) [Frank, 1997; Slavin, 1988; Park et al., 2001; Brue, 2001; …] has confused the relationship of the curves of demand (D) and supply (S) from the very beginning. It’ll be straightforward and mathematically consistent by interchanging both curves in order to rationally and rigorously explain the mechanism of the invisible hand in fundamental market behaviors (as shown in Figures b, c and d). For details, see “Toward Formal Models of the Theoretical Framework of Fundamental Economics,” Fundamenta Informaticae, 90(4), 443-459 [Wang, 2009].”

Comment

I have noticed several posts around websites by Yingxu Wang, some of them referring to the “invisible Hand” mythology. The above is fairly typical, well stated, well supported by textual evidence from modern economists, though not, alas, from Adam Smith. That’s the main source of the problem.

Parenthetically, Adam Smith did not use the standard S-D diagram, pre- or post Marshall. The S-D diagram was popularised by Alfred Marshall in his weighty tome, “Principles of Economics”. 1890. vol. 1 [there was no volume 2], Macmillan, of which several editions were published to 1929. Maths minded textbook authors for many years have pointed out the ‘error’ noted by Wang of the labelling of the vertical and horizontal axes.

More important, Adam Smith never associated his use of the “invisible-hand” metaphor with market supply and demand theories. That strange notion came about later in the 20th century, primarily by Paul Samuelson (Economics, 1948, McGraw-Hill) and is now widely assumed to be true by repetition and Samuelson's academic authority.

Adam Smith in Wealth Of Nations did not relate his use of the “invisible hand” as a metaphor for working markets. He referred to the “invisible hand” as a metaphor for the actions of a merchant who considered that sending his capital abroad was too risky. Instead he was motivated to avoid his perceived risks by acting to invest his capital in “domestic industry”.

Smith’s use of the IH metaphor described the merchant’s intended, becausemotivated, actions and their consequences for the merchant. For the merchant domestic investment was more secure for him, given his risk-aversions.

However, the merchant’s actions also had unintended consequences of which the merchant was unaware. However, Smith noted his motovated intentions also led to unintended consequences. The unintentional consequences are not the subject of the invisible-hand metaphor which describes the intended motives that lead the merchant to act to avoid the perceived greater risks to his capital by investing abroad (mentioned four times).

Smith’s use of the IH metaphor conformed to his own teachings on the role of metaphors, namely to “describe in a more striking and interesting manner” their “object” (Smith, “Lectures in Rhetoric and Belles Lettres” (1762-3, p.29). In this specific case, the “object” of the IH metaphor was the motive that led the merchant intentionally to his actions, specifically to invest his capital domestically for his own security. However, in doing so, the merchant’s action, also had unintentional consequences, specifically in this case, the merchant’s domestically invested capital added to domestic “revenue and employment” (which would not be the outcome if the merchant invested his capital abroad). That unintended consequence, which was “no part of his intention” said Smith, could have public benefits.

He also added that there were “many other cases” where similar unintended outcomes could arise from quite separate actions where individuals intentionally acting for their own limited personal interests, could have unintended benefits for society as a whole.

Sensibly, Smith’s qualified reference in the IH paragraph (WN IV.ii.9: 456) to “in this and many ofher cases” also asserts that there are, and realistically could be, many other cases where individuals acting from other motives and intending “their own gain” engage in actions that may also “promote an end” which “was no part of their intention”, or realistically in the real world, that does not “increase domestic revenue and employment”, and also produces unintended outcomes that are not describable as “public benefts”.

Much of Book IV of Wealth Of Nations discusses in detail the negative unintentional outcomes of mercantile political economy as practised across Europe. Smith’s fulsome critique of these negative mercantile outcomes are his testimony against the “merchants and manufacturers” who pursue legislation in support of their short-sighted preferences, tariffs, trade prohibitions, monopoly privileges, trade restrictions, and risky hostilities towards potentila trading partners.

2 Comments:

As to the labelling of the vertical and horizontal axes I have, belatedly, discovered that Marshall may not be to blame for starting this habit of drawing after all.

In an essay "The influence of German economics on the work of Menger and Marshall" Eric W. Streissler writes,

The "peculiar curve" is Rau's demand curve, which is published in his later (not earlier) editions-to be more precise, from the fourth edition of 1841 onwards. Cournot has presented the first demand curve in the history of economics in 1838; Rau's was the second, only three years later. But Cournot posits his curve without explanation, i.e., quasi-axiomatically, Rau presents a derivation of it, the typical German derivation: individuals differ in their preferences or, more precisely, in their willingness and ability to pay. (His curve assumes each individual buying one unit of a commodity, the typical case for reservation analysis and thus for "price bounds.") But what is more interesting in relation to Marshall: Rau's demand curve alone is drawn exactly like Marshall's, with price on the vertical axis; Cournot's (or Mangoldt's) demand curves are drawn the other way round with prices measured horizontally.(Emphasis added)

The Rau mentioned is Karl Heinrich Rau and the book is Grundsatze der Volkswirthschaftslehre, 1st ed. 1826, 4th ed. 1841.

Ref.:

Streissler, Eric W. (1990). 'The influence of German economics on the work of Menger and Marshall'. In Bruce J. Caldwell (ed.), Carl Menger and his legacy in economics, Durham: Duke University Press.

PailThank you for your observations which should be of great interest to readers brought up with the familiar s-d diagrams.It is some years tough since I regularly taught undergraduate micro.The issue came up, en passant, in my debate with David Andrews recently: ‘Adam Smith’s Natural Prices, the Gravitation Metaphor, and the Purposes of Nature’" and my initial reply: "Comments on Adam Smith’s Use of the ‘Gravitation’ Metaphor" Gavin Kennedy in Economic Thought, 2014.The dispute went to a number of comments from Geoffrey Harcourt, William Henderson, David Andrews and my responses.Just a footnote in micro-economics as far as Adam Smith's legacy is concernedGavin